Lawyers see wave of US municipal filings on cities' shortfalls

  • Business
  • Tuesday, 10 Jan 2006

WASHINGTON: Sun-splashed San Diego likes to call itself "America's Finest City.'' But a huge pension shortfall and the possibility of a bankruptcy filing are making it hard for California's second-largest city to live up to its motto. 

Faced with US$1.4 billion (euro1.2 billion) pension shortfall and exploding health-care costs for its retired workers, San Diego may well become the next Orange County, the California's city's neighbor that became the largest municipal bankruptcy case in U.S. history when it filed for bankruptcy under Chapter 9 in 1994. 

"We're a community that has lived off our good looks for too long,'' said bankruptcy attorney Pat Shea, who represented investment pool depositors in Orange County's bankruptcy and ran an unsuccessful campaign for mayor of San Diego 2005.  

"San Diego would rather be perceived as America's Finest City than actually be America's finest city. We don't want to do the hard work.'' 

San Diego's troubles aren't unique.  

Other cash-strapped cities, such as Detroit and Pittsburgh, are faced with similar problems: underfunded pension and health-care liabilities they can't afford.  

In October, Joseph Harris, Detroit's auditor general at the time, said: "Insolvency is certain. The only question is the timing of the inevitable.'' 

"This is an avalanche that's going to hit,'' said Peter Gilhuly, a bankruptcy attorney at Latham & Watkins in Los Angeles.  

"The idea of multiple Chapter 9 bankruptcies isn't out of the question. The number of municipalities that have a problem that they can't solve themselves is high. A lot of those municipalities will have to file. They haven't had an audit - like San Diego - they can't go to the bond market; they're going to hit a wall.'' 

Chapter 9 is the infrequently used section of the U.S. Bankruptcy Code that allows municipalities to adjust, or refinance, their debts while under federal court protection. 

The purpose of Chapter 9 is to allow a financially distressed municipality to continue to provide services to its residents while it develops and negotiates a plan for adjusting its debts. 

A municipality usually crafts a plan by either refinancing or extending debt maturities or reducing the amount of their principal or interest. 

Compared with the more common Chapter 11 and Chapter 7 bankruptcies, Chapter 9 filings are rare. 

Fewer than 500 governments have filed for Chapter 9 bankruptcy since U.S. Congress revised the nation's municipal bankruptcy law in 1937 following the Great Depression. 

But a growing number of financial experts say that could soon change as municipalities around the country try to come to grips with yawning gaps in their employee pension and retiree health-care funds. 

Like many large private companies, many municipalities for decades granted hefty retirement and health-care packages to their employees. 

At the same time, they underfunded their pension plans, banking on bigger returns on Wall Street. 

That worked fine, until the dotcom bubble deflated, leaving cities with billion-dollar deficits that they're now unable to make up. 

"We see different structural finance problems in different generations and pensions are the structural financial problem of this generation,'' said Shea, the California bankruptcy attorney.  

"You're going to see it in the private sector, and you're going to see it in the public sector. And it's much worse on the government side than it is on the private sector.'' 

The private sector gets some relief from the existence of the Pension Benefit Guaranty Corp., the government-sponsored agency that insures private pensions.  

But as baby boomers swell retiree ranks and health-care costs continue to spiral upward, the pension and health-care problems are only going to get worse for city governments around the country, according to Shea. 

According to John Petersen, a professor of finance and public policy at George Mason University, almost every public pension plan is now underfunded, carrying more liabilities than assets to pay them. 

Still, a wave of municipal bankruptcies is unthinkable for some public pension experts. 

"Governments can't go bankrupt,'' said Frederick Nesbitt, executive director of the National Conference on Public Employee Retirement Systems, a Washington D.C.-based lobbying group for public-sector pension plans. 

"It's not bankruptcy as it's commonly understood.'' 

Nesbitt notes municipalities can't go out of business; ultimately they have the taxing authority to resolve their financial problems. 

"To politicians who say we're in such a bind now, you have to look at what the politicians did. The reason they can't afford these plans is that in many cases they enjoyed pension holidays, and now they have to catch up.'' 

Chapter 9 differs from more familiar sections of the bankruptcy code in several ways. 

Municipalities don't reorganize like corporations do under Chapter 11, and they aren't allowed to liquidate their assets to pay off their debts as companies do under Chapter 7. 

Municipalities operating under Chapter 9 are required to file a plan of adjustment, which allows for the adjustment of creditors' claims. 

More important for cities such as San Diego, Shea said, is the fact that Chapter 9 is much more forgiving to debtors than Chapter 11. 

Under Chapter 9, municipalities can reject collective bargaining agreements and retiree benefit plans without going through the usual procedures required in Chapter 11 cases. 

Congress added Section 1113 to the bankruptcy code in 1984 to prohibit companies from rejecting labor contracts without bankruptcy court approval.  

While 1113 substantially reduced corporations' ability to reject contracts under Chapter 11, those changes weren't incorporated into Chapter 9. 

That means municipal employees' pensions and health-care benefits are at greater risk of being reduced in a municipal bankruptcy than in Chapter 11, according to Gilhuly. 

And with no PBGC to provide insurance for even partial recovery, municipal employees could lose much of what they've won through collective bargaining over the years. - AP 

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